South African Reserve Bank

From the Office of the Registrar of Banks

G2/2013

2013-01-18

To banks, branches of foreign institutions, controlling companies, eligible institutions and auditors of banks or controlling companies

Guidance Note 2/2013 issued in terms of section 6(5) of the Banks Act, 1990

Operational risk practices

Executive summary

Regulation 39 of the Regulations relating to Banks (the Regulations) requires banks, controlling companies and branches of foreign institutions (hereinafter collectively referred to as 'banks') to establish and maintain a process of sound corporate governance. This process includes the maintenance of effective risk and capital management by banks. In order to achieve the objective relating to the maintenance of effective risk and capital management, every bank should have in place the relevant required risk management processes, procedures and board-approved policies.

The purpose of this guidance note is to bring to the attention of banks specific international best practices related to operational risk and to clarify certain definitions and principles.

1. Documents issued by the Basel Committee on Banking Supervision relating to operational risk

1.1

In June 2011, the Basel Committee on Banking Supervision (BCBS) released two documents relating to operational risk, namely "Principles for the Sound Management of Operational Risk"¹ and "Operational Risk – Supervisory Guidelines for the Advanced Measurement Approaches".² The information contained in the aforesaid documents establishes sound practices applicable to all banks.

1.2

With the exception of operations pertaining to insurance, all operations related to banks need to be assessed against the principles contained in the first of the above-mentioned documents, whereas only entities that have been approved by this Office to make use of the advanced measurement approach (AMA) for operational risk have to be assessed against the principles contained in the second of the above-mentioned documents.

---

¹ Available at http://www.bis.org/publ195.htm.
² Available at http://www.bis.org/publ196.htm.

---

1.3

Banks are accordingly requested to assess their current policies, processes and practices against the principles contained in the aforesaid documents related to international best practices for operational risk.

1.4

As part of its supervisory review and evaluation process (SREP), this Office will be reviewing banks’ operational risk policies, processes and practices on a continual basis in order to assess their appropriateness, in line with the practices contained in the aforementioned two documents issued by the BCBS.

1.5

Should the outcome of the SREP conducted by this Office be deemed to be unsatisfactory, this Office may require the relevant bank to hold additional capital, calculated in such a manner and subject to such conditions as specified in writing by the Registrar, as envisaged in regulation 38(4) of the Regulations.

1.6

In addition to the principles and practices contained in the aforementioned two documents, this Office wishes to also clarify certain definitions and principles contained in the Basel II Capital Framework and other related documents issued by the BCBS related to operational risk as set out in paragraphs 2 to 4.

2. Partial use and hybrid AMA

2.1

In order to remove any potential misunderstandings relating to the partial use and hybrid AMA related to operational risk, this Office wishes to provide the following clarifying comments:

2.1.1

a partial use AMA indicates that a bank uses the AMA for some parts of its operations, and either the basic indicator approach (BIA) or the standardised approach (TSA) for the remainder of its operations, as envisaged in regulation 33(5) of the Regulations; and

2.1.2

a hybrid AMA entails the attribution of group operational risk capital to legal entities by means of an allocation mechanism as envisaged in regulation 33(9)(c) of the Regulations. Under a hybrid AMA, one AMA model is used at, for example, a controlling company consolidated level with AMA capital being allocated to legal entities, thus meaning that the legal entities do not have standalone AMA models.

2.2

Banks are therefore reminded that for the purposes of calculating their exposure to operational risk and the relevant amount of capital and reserve funds required for operational risk, banks may only apply the AMA in respect of the legal entities as described to this Office during the bank’s application process, and in respect of which the bank subsequently obtained the required approval from this Office.

3. Reverting to a simpler approach

a. Banks are reminded that once they have adopted one of the more sophisticated approaches for the measurement of their operational risk exposure, banks shall not revert to a simpler approach without the prior written approval of the Registrar, as set out in regulations 33(4) and 36(3)(b)(iii) of the Regulations.

4. Home-host supervisory co-operation and allocation mechanisms in the context of the advanced measurement approaches

a. In January 2004, the BCBS issued a document entitled "Principles for the Home-host Recognition of AMA Operational Risk Capital"³ (hybrid AMA paper).⁴ The primary objectives of the hybrid AMA paper are to:

i. clarify the key elements of supervisory co-operation with respect to the implementation of the AMA and establish a framework of principles to facilitate information sharing in the assessment and approval of AMA methodologies; and

ii. establish a set of principles to promote the development and assessment of allocation mechanisms incorporated in a hybrid AMA.

b. It should be noted that the principles set out in the hybrid AMA paper do not supersede the general principles described in the paper entitled "High-level Principles for the Cross-border Implementation of the New Accord",⁵ but rather further elaborate on these principles in an operational risk context. Also, to the extent that the hybrid AMA paper refers to operational risk capital requirements, such references are limited to the Pillar 1 capital charge only.

c. This Office is of the view that the principles set out in the hybrid AMA paper will enhance home-host co-operation and information sharing among supervisors with respect to the approval and ongoing assessment of AMA methodologies, particularly as they relate to the hybrid AMA.

In this regard, this Office would like to emphasise the need for banks interested in implementing the hybrid AMA to work closely with relevant home and host supervisors to develop allocation mechanisms that appropriately reflect the operational risk profiles of all relevant subsidiaries and that meet any other requirements of those supervisors.

5. Acknowledgement of receipt

5.1

Two additional copies of this guidance note are enclosed for use by your institution’s independent auditors. The attached acknowledgement of receipt, duly completed and signed by both the chief executive officer of the institution and the said auditors, should be returned to this Office at the earliest convenience of the aforementioned signatories.

René van Wyk
Registrar of Banks

The previous guidance note issued was Guidance Note 1/2013, dated 10 January 2013.

---

³ Available at http://www.bis.org/publ106.htm.
⁴ The hybrid AMA paper is derived from the BCBS paper entitled "Principles for Home-host Supervisory Cooperation and Allocation Mechanisms in the Context of Advanced Measurement Approaches (AMA)", which defines two sets of principles: one for home-host supervisory co-operation and another for home-host recognition of AMA operational risk capital. However, for the purposes of this guidance note, emphasis is placed on the hybrid AMA paper. ⁵ Available at http://www.bis.org/publ100.htm.

---

PO Box 6432 Pretoria 0001 · 370 Helen Joseph Street Pretoria 0002 · South Africa · Tel +27 12 3133911/0861 12 7272 · Fax +27 12 3133758 · www.reservebank.co.za